The Short Startup Equity Management Guide
The ultimate concise reference guide for managing one of your most valuable resources: equity.
Hey Founders et al. We’ve been on a bit of a hiatus, but we’re back in full swing with some valuable content for those of you who aren’t taking the summer off. We’ve created a long list of legal “startup guides” to help founders navigate the stickier legal speed bumps that plague early stagers. Today, we are publishing our first of this series “The Short Startup Equity Management Guide”.
We’ve packed these guides with resources and organized them into actionable steps you can take (or earmark for later). Over the next several weeks, we will also be publishing the following guides:
The Short Startup Incorporation Guide
The Short Startup Insurance Guide
The Short Startup Trademark Guide
The Short Startup Equity Management Guide
The Short Startup Contract Guide
The Short Startup Advisor Onboarding Checklist
The Short Startup Terms of Service Setup Guide
The Short Startup Fundraising Preparedness Guide
The Short Startup Data Privacy Guide
The Short Startup Data Security Guide
The Short Startup Employment Law Guide
… and more
so without further adeu…
The Short Startup Equity Management Guide
Properly manage equity during incorporation. SVB has a good explainer on managing startup equity. Equity is a topic you’ll need to consider from Day 1. If you use a service like Clerky to set up your company, the workflow normally includes steps and documentation for managing equity as you’re setting up the company. You can also find resources online, for example through Orrick’s Startup Forms: Equity Compensation. Be aware that equity grants involve complex securities laws, and failure to comply could result in regulatory or financial consequences to you or individuals to whom equity is issued. Therefore, it’s extremely important to consult an attorney when dealing with equity grants and management.
The following are some of the key tasks related to equity management at the earliest stages of your company:
Prepare board consent and stockholder approval forms. Assuming you incorporated your company as a Delaware Corporation (the standard for VC-backed startups), board and stockholder approval are required to adopt a stock plan, and board approval is required to issue equity grants. Cooley has a brief article highlighting where board approval is required. Services like Clerky can be used to generate board and stockholder consent forms, and you can find sample board consents online, like this Upcounsel form. Even if you use a reputable service to generate your approval forms, it’s advisable to consult an attorney to confirm your forms are complete and accurate for the specific actions the board will take.
Approve a stock plan. Your company’s stock plan establishes the maximum number of shares to be issued under the plan, and terms for issuing equity. If you use a service like Clerky to set up your company, the workflow likely includes adoption of a stock plan and related forms like stock purchase agreements and option agreements. You can also find samples online, for example through Orrick’s Startup Forms: Equity Compensation.
Issue founder equity. There is a lot of (sometimes conflicting) advice online about how to split equity among founders, such as this YC article and this Carta article. Once you’ve decided on your equity splits and vesting schedule, make sure to process the required board approvals and agreements (such as restricted stock purchase agreement). Consult an attorney to make sure your paperwork is complete and accurate, and reflects what you’ve agreed to as founders.
Confirm legal filings. When you approve your stock plan and issue founder equity, you may be required to file notices with federal or state agencies for securities law compliance purposes, and there are likely filing deadlines that you need to be aware of. Services like Clerky may automatically generate the legal notices and provide filing instructions, but it’s always important to consult an attorney to confirm the forms are complete, accurate, and timely filed.
Confirm tax filings. Founders often file an 83(b) election form for tax benefit purposes. Refer to this Cooley article for more information. Be aware of filing deadlines and if applicable, a financial advisor or tax advisor regarding filing an 83(b) election.
Set up an equity management system for your early-stage company.
Prepare forms for issuing employee and advisor equity. Going forward, it’s convenient to have an organized file with templates for the most common forms you’ll use when you issue employee or advisor equity. Note that these forms may have been approved when the board adopted the stock plan. It’s extremely important to make sure that equity is issued correctly to avoid regulatory and/or financial penalties and problems in the future, so in all cases consult an attorney whenever you issue equity.
Common forms that you’ll use when you’re issuing equity to employees or advisors include:
[Board consent. Board consent is required to approve equity grants for employees and advisors. You can find sample board consents online, like this Upcounsel template. (Note that this form is different from the form linked above to approve founder equity grants.) Even if you use a reputable service to generate your approval forms, it’s advisable to work with an attorney to confirm your forms are complete and accurate for the specific actions the board will take.
Legal notices. Similar to issuance of founder equity and stock plan adoption, when you issue equity to employees or advisors, you may be required to file notices with federal or state agencies for securities law compliance purposes, and there are likely filing deadlines that you need to be aware of. It’s strongly advisable to work with an attorney to confirm the forms are complete, accurate, and timely filed when you issue equity.
Tax documentation. Depending on the type of equity grant, the recipient may elect to file an 83(b) election. The individual who receives the equity grant, not the company, is responsible for the 83(b) election filing, but you may be asked to provide information or answer questions in connection with their filing. If you have any questions, consult an attorney, regarding the company’s role in providing assistance or information in connection with an individual’s 83(b) election.
Set up a cap table management system. Good cap table management is essential for early stage startups. A well-maintained cap table allows you to understand your potential dilution in future fundraising rounds (learn more here), and helps ensure that you do not issue more shares under the stock plan than were originally approved. Investors will likely ask to see your cap table as part of their due diligence process, and may request rights to view and monitor your cap table post-investment. Over time the cap table serves as a signal for your company as explained here. You may opt to manage your own cap table using templates like Cooley’s. You may also use one of the many cap table management programs available, such as Carta, Pulley, Clerky, Angellist Stack, Fairmint, or others.
Know the triggers for 409a valuations. When you issue stock options to employees or advisors, you will need to determine the “strike price” or fair market value of your company’s stock. Correctly pricing stock reduces the chance that the equity holder could face tax penalties. This AngelList article explains 409A valuations in more detail. There are many vendors that can assist with 409A valuation preparation such as Carta, Pulley, etc. Make sure you’re aware of budget and schedule if you need a 409a valuation. The cost and time required for a 409a valuation depends on factors like the complexity of your situation and how busy the 409a valuation service provider is. Work with an attorney to confirm the circumstances that would require you to prepare a 409a valuation for your company.
The most common triggers for needing a 409a valuation are:
Issuance of stock options;
Material events impacting the value of the company such as certain types of financing rounds, M&A events, or significant business model changes; and
409a valuation expiration (a 409a valuation is valid for 12 months).
Thats’s all for now. Stay Lawyerly,
Brian
PLEASE NOTE: This is not legal advice, and thoughts and commentary are solely my own, and not those of Scale LLP.